The city of Waupaca stands to lose $80,000 due to a Sept. 15 ruling by the Wisconsin Court of Appeals District IV.
The Court of Appeals reversed a circuit court decision in a foreclosure involving Fairway Properties. The lower court granted priority to the city’s claims under a development agreement.
Located near Foxfire Golf Course, Fairway Properties began developing a residential project in Tax Incremental Financing (TIF) District 6.
The project failed and Baylake Bank, which held a mortgage on the property, filed a foreclosure in February 2009 against Fairway Properties of Wisconsin and Waupaca developers Robert Steidl and James Tarantow, who had ownership interests in the property, according to court documents.
At the time of the foreclosure, Fairway owed Baylake Bank nearly $570,000.
The city of Waupaca was also named in the suit because Fairway had entered into a TIF development agreement.
The city uses TIF agreements to finance its investment in new infrastructure. When new businesses or new subdivisions are developed, they increase the value of the property and increase the local tax base. The additional property taxes, or incremental tax growth, generated by development in a TIF district is captured and used by the city to pay for its investment.
In November 2000, Fairway entered into a TIF agreement with the city. Under its TIF agreement, Fairway committed to developing the property into $4.5 million of single-resident housing. The development goal was spread out over an 11-year period.
For each year that Fairway failed to meet its annual goal, the developers were required to pay a “liquidated damages penalty” to the city. The penalty was based on the amount of projected new property taxes that Fairway failed to pay the city as a result of not meeting its annual development goal.
“In the event Fairway Properties failed to expend the development costs called for in the agreement, a penalty would be imposed which basically was the difference between the tax levy if the project was completed as agreed, and the actual tax levy,” City Attorney John Hart noted in a reply brief to the Appeals Court. “In effect Fairway agreed that it would pay the tax on the ‘tax incremental base’ and the ‘value increase’ as if it had expended the development costs as agreed.”
According to court documents, Fairway executed a real estate security agreement with Baylake Bank in December 1999, and secured a mortgage for the property to be developed with Baylake in July 2001.
Baylake Bank was not a party to the TIF agreement and had already committed at least $500,000 to the project by the time the TIF agreement was signed, according to the appellant brief filed by Baylake Bank’s attorney, Randall Nesbitt.
The development plan failed and Fairway fell into default. Baylake filed for foreclosure, seeking a summary judgment that its mortgage claim held priority over all other claims.
The city of Waupaca responded to the foreclosure action by claiming that Fairway owed the city back taxes from 2006 through 2008, as well as property taxes in 2009, totaling more than $150,000.
The city also argued that Fairway owed the city more than $80,000 in penalties for the years 2006 through 2009 under the terms of the TIF agreement.
While Baylake agreed that the property taxes had priority over the amount owed on the mortgage, the TIF penalties were subordinate to the mortgage.
The city disagreed and asserted that the TIF damages were a property tax and therefore had priority over the mortgage.
Under Wisconsin statutes, the taxes that are owed on a property have priority over the amount owed on a mortgage in the event of a foreclosure.
In his affidavit in support of the city’s position, City Administrator Henry Veleker indicated that the city of Waupaca spent more than $650,000 in project costs as a result of its TIF agreement with Fairway Properties.
The city had installed sidewalks, wells and driveway approaches in the development and was seeking to recoup some of its costs.
Waupaca County Circuit Court Judge Philip Kirk ruled in favor of the city’s claim that the penalties under the TIF agreement were taxes and therefore had priority over the mortgage.
Quoting the agreement between the city and Fairway, Kirk noted, “The payment due is a special charge which may be entered in the tax roll as a charge against the real property … then owned by the developer and collected in the same manner as real estate taxes. The amount due is a lien upon the property superior to all other liens.”
Kirk said that even though they are described as penalties, the amount owed under the agreement for damages are the same as property taxes.
Baylake appealed the circuit court’s decision and argued that the city’s “liquidated damages penalty as set forth in the development agreement were unrelated to any services provided by the city of Waupaca.”
In its ruling, the Appeals Court found that the city is only allowed to enact taxes that have been specifically authorized by state law. The ruling argues that the city is authorized by law to set up TIF districts, that it can divert property taxes within the district to support its investment and that the property taxes that a developer owes take priority over any other liens.
However, the Appeals Court did not recognize that the damages owed under the TIF agreement for “anticipated taxes” constituted actual property taxes under state law.
“There is no dispute that the city may, by means of a contract, create a back-up mechanism should its hope for taxation fall through. But that does not turn the back-up mechanism into a tax,” the Appeals Court concluded. “The crux of the issue here is whether that contractual mechanism, which comes into play only in the absence of property to tax, is itself an authorized property tax.”
The Appeals Court found that there was no explicit language in state law that the city could point to as authorizing it to treat contractual penalties as a form of property tax.
The case was remanded to circuit court to grant summary judgment to the bank consistent with the appellate ruling.